Alternative Minimum Tax (AMT) is not something everyone is exposed to, but when you are, it can often create confusion and add a layer of complexity to financial planning that many are not prepared for. This article will help outline how AMT may affect your financial situation.
The Alternative Minimum Tax was created in the 1960s with the intention of preventing taxpayers with substantial income from utilizing various deductions in order to dodge the traditional federal income tax system. The AMT system runs parallel to federal income tax for individuals, trusts, and estates. Corporations were also once subject to AMT until this was repealed by the Tax Cuts and Jobs Act in 2017. AMT is calculated to determine if taxpayers are paying their “fair share” in a given tax year. For individuals, the AMT system recalculates income tax using fewer deductions and exemptions – for example the standard/itemized deduction – and then adds back specific tax preference items to an individual’s gross income.
A few of the preference items that we often see that affect AMT are listed below. There are several other influencing factors which are less common, and for the sake of this article, have been left out. IRS Form 6251 has the full details.
- Capital gains from exercise of stock options (i.e., Incentive Stock Options)
- Qualifying exclusion for small business stock
- Interest on private activity bonds
- Deductions for accelerated depreciation
Once the Alternative Minimum Taxable Income (AMTI) is calculated, the annual AMT exemption is applied to determine what amount is subject to AMT rates. In 2021, the AMT exemption is $73,600 for single filers and $114,600 for married filing jointly. The exemption begins to phase out for single filers at $523,600 and at $1,047,200 for married filing jointly.
After determining the minimum tax base, the AMT tax rate of 26% is applied on the first $199,900 (as of 2021). Amounts above this figure are then subject to the second and final AMT tax rate of 28% to determine your overall AMT liability. After all is said and done, you will owe the higher of the two, traditional tax liability or AMT liability.
One of the most common areas where we see clients introduced to AMT is when Incentive Stock Options (ISOs) enter the financial picture. ISOs are often awarded by companies in lieu of direct compensation (i.e., annual salary), as a way to incentivize an employee to help grow the value of the company. Please check our upcoming blog post for specific details regarding Incentive Stock Options and the impact of AMT.
The majority of taxpayers don’t encounter AMT, but when they do, it can be a complete surprise. Here at Merriman, we take a comprehensive approach to fully understand your financial landscape. In most situations, it is wise to involve a CPA when facing the AMT due to the complexity and varying timelines that affect cash flow. Please reach out to Merriman if you would like to discuss your situation in greater detail.
Watch for our upcoming blog post which will go into further detail about Incentive Stock Options (ISOs).
Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be relied upon as such. Advisory services are only offered to clients or prospective clients where Merriman and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Merriman unless a client service agreement is in place.
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Mike came to Merriman after several years spent in corporate finance and brought with him an innate sense of discipline. Whether surfacing through routine, structure, or a desire for predictability, discipline often guides his decision making. He enjoys helping clients determine goals and create a plan to achieve them. He sincerely believes you can accomplish all you set out to with the right structure and discipline.
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